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FINANCIAL CHRONICLE™ » FINANCIAL CHRONICLE™ » Is this Crisis due to SEC’s Over Regulations or Illiquidity

Is this Crisis due to SEC’s Over Regulations or Illiquidity

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laka

laka
Senior Equity Analytic
Senior Equity Analytic
Is this Crisis due to SEC’s Over Regulations or Illiquidity

Last week I just asked an investor that what the reason is for down trend of the stock market.
He easily replied me that it’s just because of CEC and he further said that he hates SEC and its regulators.Then he explained me why they are responsible for current down trend. According to him ASI should be at 10,000 by the end of this year and 13,000 by the end of the year 2012.But SEC wanted to stop this so they
introduced price band and when it wasn’t successful they introduced credit rules and further they allowed for big IPOs
without thinking market condition. Anyway now problem is solved and credit rules are subject to amend. When
notice is published on increased credit facility of Brokers, we can have good old days again. According to him
this is the good time to collect shares as market will start running sooner than later.

I think most of the investors are agreed with him looking the surface of the problem. In my opinion problem is neither
SEC nor it’s regulation. It’s a liquidity problem or in other words it’s due to lack of cash. It’s like USA property crisis
arises in 2008. At that time property values were increase by considerable percentage but finally they were bankrupted
since liquidity problem. In certain time of 2011, ASI had been up by 400% when compared to 2009. That means
Market Capitalization has been up by 4 times in other words it is increase from Rs 700 B to Rs 2,800 B.

For an example
Just think there is a Stock Market with 3 investors called A, B and C and 3 stocks called X, Y and Z. A have Rs 100,000
worth stock X parcel bought on cash basis and B also have Rs 100,000 Worth stock Y parcel bought on cash basis and
C also have Rs 100,000 worth stock Z parcel bought on cash basis. Accordingly there are Rs 300,000 cash in put at the
beginning whereas Market Capitalization also takes same figure. Now they start trading with each other like this.
A sell his X share parcel to B for Rs125,000 and use those sales proceed to buy Z share parcel from C for Rs 125,000.
Then C buys Y share parcel from B for Rs 125,000. At the end of the 1st round Market Capitalization is up by 75,000
to Rs 375,000 while cash position remaining same as Rs300,000. If people use their sales proceed to buy each parcels
without withdrawing money , this system can be continued unlimited times. If this happen 10 times , at the end of
the 10th time the market capitalization would be Rs 1,050,000 while remaining the cash position still at Rs 300,000.
That is how bubble/crash can create without credits. If one party withdraw their money without further buying, then
crisis starts and then others also get panic and try to withdraw their money by selling. This leads to stock market crash.
But if there is significant % of cash inflows to the system compared to the increase % of Market Capitalization ,this
may not lead to crash.

This is what happened in CSE over last 2 years. End of the September of 2010, MPI which is Blue Chip Index stood
at its peak level (7,800).At that time market capitalization had been increase by 4 times whereas Market PER was
above 25 level. Then foreigners decided that market was overvalued so they sold and exited the CSE. in the year 2011
there is Net Foreign Outflow of more than Rs 10Bn. At the same time some local Investors also withdrew money and
applied for IPOs. Further credit clearing was also helpful to create more active bears. Now market is with lack of
cash in other way there is a liquidity problem because Market Capitalization was increase by 4 times but Net Cash
Inflow takes minus figure. As a result of this there is huge selling pressure for Blue Chips. Since they take high weight
of Indexes, there should be huge cash inflows to buy Blue Chips to have a sustainable growth of Index. Since no one
enters cash to the CSE, people gave up the idea of Blue Chip and selected penny stocks and illiquid shares that can be
manipulated easily. After 2011 share manipulations highly dominated and PAP,LHCL,HVA,RGEM,AAIC are some of them. These manipulations could wash investors’ brains.
They laughed at the word “fundamentals” saying “Fun-da-mental”. Once there was a time in CSE (from 2011 Feb to July)
where there is a Negative relationship between ASI and MPI. That means ASI was going up whereas MPI was going
down. Ultimately now everyone is stuck with the market including manipulators. Even manipulators can’t now
manipulate their shares due to margin call.

Simply when there is no demand for blue chips, their prices are also going down. Since they
take significant weight of index, Manipulators can’t stop the Indexes going down by manipulating their lower
weighted shares. Then everything is going to disaster until we meet strong cash inflows to buy blue chips.
That means MPI /Blue Chips should start running to have sustainable growth. So we highly need foreign participation
or huge local cash investments to face such a high market capitalization (Rs2.2T). In my opinion foreigners may
not come to CSE until ASI is above 5,000 as Market PER (14) is still high for them to re enter. Therefore ASI is highly
probable to hit below 5,000 sooner than later due illiquidity of Blue Chips.


Q: Can we blame to SEC for over regulation (i.e. Price Band and Credit Rules)?
We should be thankful to SEC for making their best effort to reduce the gravity of crash even under varies influences.
As a result of this we still don’t say this is a crash. We could still say that this is only a down trend. SEC did it because
they knew the poor cash position of the stock market and they knew a crash/bubble can occur even at zero
credit level. If they didn’t do like that ASI would hit 10,000 or 12,000 and then would lead to Bangladesh type crash.
Anyway I wish they had unique policy on credit rules and had more regulations regarding IPO pricing method.

Q: Brokers Credit Facility is subject to amend by 3 times. Can we have good old days when rules are amended?
As I think people may not use this credit facility to buy Blue Chips like COMB,SAMP,DIST and on behalf of that they
may use credit to buy penny stocks and illiquid shares what they have already stuck since retailers are fully brain
washed as “Fundamentals don’t work here”. So credit increase may not be able to any significant impact to Indexes.
Further when people use credit to buy penny stocks and illiquid shares, crash may be worse than earlier. That’s why
the key persons of SEC resigned before it happen.

Q: What is the real solution for this problem?
Simply we need cash inflows for Blue Chips to make them liquid. Since local investors are suffering with lack of cash,
we highly need foreign inflows. It’s better if we could avoid foreign selling and exit. Expropriation Bill also adversely
affects to discourage foreign participation.CSE and Stock Brokers have to do more road shows in abroad to attract
them. Further manipulations should be controlled up to considerable level. There should be time gap among each
IPOs as well.

Q: What is the supportive level?
Down trend will further continue till CSE have cash inflows to buy Blue Chips. ASI at 5,000 may be supportive level only
if foreigners enter to CSE at that level. Otherwise we have to wait at any level (even 4,000) till they come to CSE.

laka

laka
Senior Equity Analytic
Senior Equity Analytic
For comfortable reading, Pls download the attachment
Comments are wellcome...

Kumar

Kumar
Senior Vice President - Equity Analytics
Senior Vice President - Equity Analytics
Thanks for sharing.
Please post the source link also.
If it is news could you post in news section?

laka

laka
Senior Equity Analytic
Senior Equity Analytic
Nop.This is my article only for Sri Lanka Equity Forum.

Kumar

Kumar
Senior Vice President - Equity Analytics
Senior Vice President - Equity Analytics
@laka wrote:Nop.This is my article only for Sri Lanka Equity Forum.

My apologies and thanks for good service mate.

Universalgoal


Assistant Vice President - Equity Analytics
Assistant Vice President - Equity Analytics
whts the reason forighners to enter the market

Major reason is CSE illiquidity

even for a hotel (we are not going if it is not crowded and not happening) Very Happy Very Happy

kama


Manager - Equity Analytics
Manager - Equity Analytics
I wish we had rep system to give you + rep.

People like dindon, amilaela, rajaram, sanjaya351, bakapandithaya, krishanakash, and bla bla bla should read this without daydreaming...

kama


Manager - Equity Analytics
Manager - Equity Analytics
@Universalgoal wrote:whts the reason forighners to enter the market

Major reason is CSE illiquidity

even for a hotel (we are not going if it is not crowded and not happening) Very Happy Very Happy

Still market PER is high for them @ 14-15. If they know that ASI is further going down why they come now ? They might enter to CSE when Market PE is below 10.

smallville

smallville
Associate Director - Equity Analytics
Associate Director - Equity Analytics
@laka wrote:Nop.This is my article only for Sri Lanka Equity Forum.

Good explanation in deed.. After sometime I read something fully since there was no source mentioned Wink Twisted Evil
Thanks for taking time in writing a valuable insight that we all want to refresh our memories from the starting of events..

Still we're in danger looking for the bottom.. I dont think the below 5000 level is possible but im in the view that ASI has to drop to at least 5500 since we see NATO going on with the officials these days.. Also if any positive news is leaked, 10% up is on the cards too..
Further, any rules to be imposed or banned, it would take till January as the action time..

pushpakumara


Senior Manager - Equity Analytics
Senior Manager - Equity Analytics
This is due to both lack of liquidity and regulatory actions. Lack of liquidity is due to most people lost their monies in investing at CSE during 2011. The proximate cause for this is due to wrong implementation of new rules on the market. Only a small section of the market always on the winning mood and not the rest.

When there is no buying power market will be like this until some new monies are coming into the market.

Excessive credit is bad because it will enable innocent and ignorant investors to flex their muscles and follow fake rallies and get into trouble. When there is limited credit manipulators can not create bigger fake rallies as there are only a few who can afford such rallies. That way innocent investors will be protected and manipulators can not make monies as they wish. My opinion is that way CSE can control market manipulation. Slow and steady growth of the market is better than one we had in 2009/2010. Because no one will want to see a market behaviour what we experienced in 2011 in our trading lives. In a way that will give assurance to innocent investors that they are in safe hands. On the other hand foreign investors too will feel it is secure to invest at CSE. But I am not sure how the day traders will be affected as they can not make monies as in 2009/2010. It is difficult to satisfy all. But in general limited credit is better than excessive and uncontrolled credit. Let us see what is on cards.



Last edited by pushpakumara on Wed Dec 21, 2011 12:16 pm; edited 2 times in total (Reason for editing : additions/deletions)

Liber Abaci


Senior Equity Analytic
Senior Equity Analytic
@laka wrote:Is this Crisis due to SEC’s Over Regulations or Illiquidity

Last week I just asked an investor that what the reason is for down trend of the stock market..

Brilliant analysis, Some thing worthy of reading .....for a long time.
Thank you for your time effort and willingness to share.
I agree with your identification of the problems / issues , but do not agree with the solutions ,specially.... road sows abroad.. to attract foreign investors. (That's what Govt (PBJ / NC) is also trying to do, but it won't succeed .)
Will post my opinions later.

Slstock

Slstock
Director - Equity Analytics
Director - Equity Analytics
Very good overall explanation.

However, if ASI goes to 5000 many small timers will get completely wiped out. Though the drop from ASI high ( 7800) to 6000 was big , the drop from 6000-5000 will be major leading to a very negative "almost a crash" situation wiping out lot of small timers who even hold undervalued shares to market. If this happens getting investor confidence back will be very hard.

What essentially CSE needs is a systematic correction of the overvalued and not a whole market dragging down to kill every share.

At ASI 5000, just think the value of SAMP, DIMO, DFCC/APLA for example ( Some of them have corrected over 50% from top. I just picked some fundamentals trading already well below market PE and PBV).

By the way, just look at the top 20 market capitalization companies. Note that some are trading at PEs of 20 or more still. They need to be corrected also along with other overvalued "junk". I f this happens naturally ASI will see a significant drop with Market PE reduction without overvall killing of market.

How to do that is somethign to ponder. Right now when market goes down everythign goes down. Good bad and the ugly.

Question is will authorities do nothing and wait till ASI hit 5000. Also this expropriation bill and the way it was carried out is very bad for foreign investor confidence ( and ours too).

UKboy

UKboy
Senior Vice President - Equity Analytics
Senior Vice President - Equity Analytics
@Universalgoal wrote:whts the reason forighners to enter the market

Major reason is CSE illiquidity

NO.
Unless they can grab fundamentally sound shares for dirt cheap they will NOT come back to this market. Thats the main reason.

If you can read laka's post carefully you can find why they were leaving CSE.

As slstock mentioned id**c things like expropriation bill does not help to bring them back.

aj


Assistant Vice President - Equity Analytics
Assistant Vice President - Equity Analytics
When an investor (may be a foreign fund) want to invest in these stocks, they don't just look at the final profit number or the PE ratio broker reports show. That's how Sri Lankan investors invest. Sri Lankans haven't seen PE ratios like 11, 12 for a while. They thought PE 20s were fairly valued number while anything under 19 was undervalued.

For real investors they check how that profit has come and whether the company can do it consistently over the next years. That's where Sri Lankan companies fail. Look at the stocks with PE under 15 and you'll see the profits came by selling their assets or negative goodwill or giving a higher value for a property they control. These are not profits. For an extreme example, there is a company which sold one of their hotels and showed profits. Some companies wound down companies they own. Even the ones you think are very undervalued, if you look at the numbers closely you'll see the profits are not growing and the expenses are growing. When you give a PE 15 or even 25, there is a reason for doing that. That you expect 'growth'. But almost all of the reputable companies you see don't have that.

That is where CSE fails. The stock prices don't even come close to the core business growth. Other than the manipulated market issue, that's the main reason foreign funds are exiting. You have to blame the company directors.

Genting


Senior Manager - Equity Analytics
Senior Manager - Equity Analytics
If ASI hit 5000-(drop of 15%), blue chips will be the main contributors.
Most blue chips may hit 20%-30% price fall.

Looks too scary to imagine.. but can happen...unless authorities do something...

Aamiable


Vice President - Equity Analytics
Vice President - Equity Analytics
try to attract investments..giving credit is not a solusion... investments would come in 2012.

Stockmate


Manager - Equity Analytics
Manager - Equity Analytics
I had indicated the possible worst bottom in this char months ago.
laka's values matches with it. See the area marked with a Blue curly bracket

https://i.servimg.com/u/f46/16/66/37/07/market11.jpg

Slstock

Slstock
Director - Equity Analytics
Director - Equity Analytics
@aj wrote:When an investor (may be a foreign fund) want to invest in these stocks, they don't just look at the final profit number or the PE ratio broker reports show. That's how Sri Lankan investors invest. Sri Lankans haven't seen PE ratios like 11, 12 for a while. They thought PE 20s were fairly valued number while anything under 19 was undervalued.

For real investors they check how that profit has come and whether the company can do it consistently over the next years. That's where Sri Lankan companies fail. Look at the stocks with PE under 15 and you'll see the profits came by selling their assets or negative goodwill or giving a higher value for a property they control. These are not profits. For an extreme example, there is a company which sold one of their hotels and showed profits. Some companies wound down companies they own. Even the ones you think are very undervalued, if you look at the numbers closely you'll see the profits are not growing and the expenses are growing. When you give a PE 15 or even 25, there is a reason for doing that. That you expect 'growth'. But almost all of the reputable companies you see don't have that.

That is where CSE fails. The stock prices don't even come close to the core business growth. Other than the manipulated market issue, that's the main reason foreign funds are exiting. You have to blame the company directors.

Aj, sometimes when I read your post I feel you are an extreme bear Wink But there is certainly truth in what you say above, that some companies show inflated profit through games and how the real analysts will look at it negatively.

But, I think if one believes in investment ( with patience), one's job is to identify the few good in the mud and slowly collect. We cannot say all shares at CSE is totally overvalued and crap though they are many which fit the bill.



Side note about foreigners:


CSE is a very small market. Whole market capitalization is significantly below even certain individual companies at NYSE. ( Just look at Exxon for example) .


Though small, CSE is still very much reliant on foreigner inflow whether it is good or bad. Foreign funds buy early ( opposite to us) and sell when their targets are accomplished , when companies are overvalued, or maybe simply when they need money. There might be foreigners who bought at dirt cheap before the boom CSE and now exiting for one of the reasons I mentioned above. So ot is important identify why at times foriegner are selling certain share. If the company you hold is solid do not panic. They maybe exiting for profit.

Also note at the same time foriegner usually will buy higher market capitalization and higher liquid companies. Unfortunately most of these companies at CSE maybe not bargains yet for them to buy back. But it does not mean there are no good shares at CSE Wink

One fine day , hope we will not be so dependent on foreigners. But right now there things we can learn from them like when to enter and exit market.

rijayasooriya

rijayasooriya
Senior Vice President - Equity Analytics
Senior Vice President - Equity Analytics
@laka wrote:Simply we need cash inflows for Blue Chips to make them liquid. Since local investors are suffering with lack of cash,we highly need foreign inflows. It’s better if we could avoid foreign selling and exit. Expropriation Bill also adversely affects to discourage foreign participation.CSE and Stock Brokers have to do more road shows in abroad to attract them.
I can not understand this policy.If our market is attractive why we should go after foreigners ? Do we want to give them an oppurtunity to invest now and then sell it to us later with a huge profit ? What will happen ? Our money will flow out from our country.Is it beneficial to our country ?
Who are the local investers who lack money ? We should motivate our local investers and at the sametime government funds can invest now.If this is a golden oppurtunity why do we hand over it to foriegners ?
I raised this issue several times in this forum but only few seems to be interested.

Stockmate


Manager - Equity Analytics
Manager - Equity Analytics
rijayasooriya

We need about a trillion. If the ETF fund is fully invested in stocks problem solved. But that never happens.

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